Investing in bonds
There is a relative increase in appetition for retail investors to participate in investing in the bonds’ primary and secondary markets. There are many and various reasons for this trend, which started about three years ago - but one of which is that investors are trying as much as possible to put a financial cushion by investing in fixed income instruments (bonds) — given bonds’ contractual nature of paying fixed amounts in pre-agreed periods.
What is a bond? A bond is a type of fixed-income security issued by either the Government, (Central, Local, or Government Agents) or Private companies in exchange of funds lent to it by investors. A bondholder is the lender, while the government or a company is the borrower. The bonds instrument state how much money is owed, coupon/interest rate to be paid, payments periods and cycle, bond’s maturity date, etc. There are various types of bonds – it depends on the issuing entity or the use of the proceeds from the bond issuance.
Simply, when you buy a bond, you are basically making a loan to a government (if it is Treasury bonds), or a company (if it is Corporate bonds). As it is, financial markets love to make the idea of investing in bonds seem complex, but — it is pretty simple. Bonds are loans. When you buy a Treasury bonds, you lend money to the Government, or when you buy a corporate bond, you lend money to a firm. And when you lend money to a less dependable firm - and, hence, a high-risk firm - it is called a high-yield bond, or a junk bond!
What are some of the key considerations on investing in bonds? Well, you may need to ask yourself some of these questions: (i) Should you buy taxable or tax-free bonds? (Corporate bonds vs. Treasury bonds). (ii) Should you buy shorter-or-longer term maturities? (Interest rate to be earned vs liquidity needs). (iii) What yield and benchmarks should you use? (Inflation, or return on other investment options); (iv) Do you want to assure yourself against decline in prices of bonds? (v) What about Coupon? [Currently, bonds issued by the Government have: 2-Year bonds which pay a coupon of 7.82 percent; 5-Years: 9.18 percent; 7-Years: 10.08 percent; 10-Year: 11.44 percent; 15-Years: 13.50 percent; 20-Years: 15.49 percent, and the 25-Year bond which pays a coupon of 15.95 percent]; (vi) Should you invest in bonds or bonds fund? (Sh1 million for a bond vs Sh50,000 for monthly reinvestment on bonds units issued by Unit Trust?)
So, how much can you real earn as money lender (or a bond holder)? Despite the pre-determined coupon rates as indicated above, but it real depends as there is an element called yield, which depends on the pricing of the bonds both at the primary market and secondary market. But also, the above applies only to government bonds, what about corporate bonds? How much can you earn to lending to a company issuing a bond?
Under normal circumstances, by lending money to the Government you may earn less income compared to if you are lending money to a company — why? Because there is little chance that the government may renege on its financial markets debt obligations— why? Because it is a significant reputational matter when a government fails to honour its bonds obligation. It basically impacts the overall cost of funding in the economy. For this reason, the interest rates in governments bonds ought to be relatively lower because of the less risk related compared to corporate bonds. Whatever the case — these are matters of trade-offs between risk and reward.
The other critical factor for investments in bonds is the duration of the loan. As indicated above, our government bonds issuance programmes cover the 2-to-25 years tenure, with lower coupon and yields on the short tenor compared to the longer tenure, for the reason that you receive a higher interest rate for lending the money over a longer period - if only because it is riskier!
Why do investors want to own bonds? For a start, they are much safer than shares.
That’s because the borrower is legally required to repay you, and at the agreed rate and time frame. If you hold a bond to maturity, you will receive all your original loan (called principal), plus the interest payments — unless the bond issuer goes bankrupt!
As an asset class, statistics globally, indicate that bonds deliver positive calendar-year returns approximately 85 per cent of the time. Who can invest in bonds? Anyone can!
But, mostly preferred by retirees, or investors with a day job who cannot tolerate the volatility of shares, or who cannot invest in exotic and high adrenaline non-financial assets classes. The less conservative investors might also consider putting smaller portion of their assets in “high-quality bonds” to meet any financial needs especially in times of high liquid needs. But also, more aggressive investors may also put a portion of their money in the bonds to provide them with liquidity that they can use when the stock market goes on sale mode.
Now, this may as well sound complex to some of us, but as long as you have Sh1 million, you can happily start to invest in Treasury bonds. And you can buy a bond either in the primary market at the Bank of Tanzania or you can buy a bond in the secondary market at the Dar es Salaam Stock Exchange. What you need to do is place an order with your stockbroker or your banker – both of them have access to both the Bank of Tanzania and the Dar es Salaam Stock Exchange.
